Countervailing power in wholesale pharmaceuticals

There are a number of theories in the industrial organization literature explaining the conventional wisdom that larger buyers may have more "countervailing power" than small buyers, in that they receive lower prices from suppliers. We test the theories empirically using data on wholesale prices for antibiotics sold through various distribution channels-chain and independent drugstores, hospitals, HMOs-in the U.S. during the 1990s. Price discounts depend more on the ability to substitute among alternative suppliers than on sheer buyer size. In particular, hospitals and HMOs, which can use restrictive formularies to enhance their substitution opportunities beyond those available for drugstores, obtain substantially lower prices. Chain drugstores only receive a small size discount relative to independents, at most two percent on average, and then only for products for which drugstores have some substitution opportunities (i.e., not for on-patent branded drugs). Our findings are roughly consistent with collusion models of countervailing power and inconsistent with bargaining models and have implications for recent government proposals to form purchasing alliances to reduce prescription costs.